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Advanced Capital Budgeting 4 CW

This document discusses sensitivity analysis for a capital budgeting project considering various parameters like sales price, unit cost, sales volume, initial outlay, and project lifetime. It provides calculations to determine the percentage change in each parameter that would reduce the project's NPV to zero. For example, it finds that a 7.9% decrease in sales price, an 11.85% increase in unit cost, or a 23.68% decrease in sales volume would make the project non-profitable. It also calculates that an increase of 31.03% in initial outlay or shortening the project lifetime by 22.97% would eliminate profits. Alternative calculations are also provided to estimate the impact of a 10% change in certain parameters

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42 views4 pages

Advanced Capital Budgeting 4 CW

This document discusses sensitivity analysis for a capital budgeting project considering various parameters like sales price, unit cost, sales volume, initial outlay, and project lifetime. It provides calculations to determine the percentage change in each parameter that would reduce the project's NPV to zero. For example, it finds that a 7.9% decrease in sales price, an 11.85% increase in unit cost, or a 23.68% decrease in sales volume would make the project non-profitable. It also calculates that an increase of 31.03% in initial outlay or shortening the project lifetime by 22.97% would eliminate profits. Alternative calculations are also provided to estimate the impact of a 10% change in certain parameters

Uploaded by

sairad1999
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We take content rights seriously. If you suspect this is your content, claim it here.
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ADVANCED CAPITAL

BUDGETING DECISIONS
CLASS 4
Advanced Capital Budgeting Decisions Class Work

Topic Sensitivity Analysis

Question 1:
XYZ Ltd. is considering a project for which the following estimates are available:

Initial Cost of the project 10,00,000


Sales price/unit 60
Cost/unit 40
Sales volumes
Year 1 20000 units
Year 2 30000 units
Year 3 30000 units
Discount rate is 10% p.a.
You are required to measure the sensitivity of the project in relation to each of the following
parameters:
a. Sales Price/unit
b. Unit cost
c. Sales volume
d. Initial outlay and
e. Project lifetime
Taxation may be ignored.
(Source: ICAI)
ANSWER:
Calculation of NPV
20,000  20 30,000  20 30,000  20
NPV = - 10,00,000 +  
1.1 1.21 1.331
= - 10,00,000 + 3,63,636 + 4,95,868 + 4,50,789
= 13,10,293 – 10,00,000
= 3,10,293/-.
Measurement of sensitivity is as follows:
a. Sales Price:
Let the sale price/Unit be S so that the project would break even with 0 NPV.
20,000   S  40  30,000   S  40  30,000  S  40 
10,00,000   
1.1 1.21 1.331
S – 40 = 10,00,000/65,514
S – 40 = 15.26

2 Sanjay Saraf Educational Institute Pvt. Ltd.


Advanced Financial Management Class Work

S = 55.26 which represents a fall of (60-55.26)/60


Or 0.079 or 7.9%

Alternative Method
10,00,000  20
 15.26
13,10,293
S = 40 + 15.26
= 55.26

Alternative Solution
If sale Price decreased by say 10%, then NPV (at Sale Price of 60 – 6 = 54)
20,000  14 30,000  14 30,000  14
NPV = -10,00,000 + 1
 2

 
1.1  
1.1 1.1 3
= -10,00,000 +2,54,545 + 3,47,107 + 3,15,552
= -82,796
3,10,293   82,796 
NPV decrease (%) =  100  126.68%
3,10,293
b. Unit Cost:
If sales price = 60 the cost price required to give a margin of 15.26 is ( 60 – 15.26) or
 44.74  40 
44.74 which would represent a rise of 11.85% i.e.,   100 
 40 
Alternative Solution
If unit cost increased by say 10%. The new NPV will be as follows:
20,000  16 30,000  16 30,000  16
NPV = -10,00,000 +  
1.11 1.12 1.1 3
= -10,00,000 + 2,90,909 + 3,96,694 + 3,60,631
= 48,234
3,10,293   48,234 
NPV decrease (%) =  100  84.46%
3,10,293

c. Sales volume:
The requisite percentage fall is:
3,10,293/13,10,293 × 100 = 23.68%
Alternative Solution
If sale volume decreased by say 10%. The new NPV will be as follows:
18,000  20 27,000  20 27,000  20
NPV = -10,00,000 + 1
 2

 
1.1  
1.1 1.1 3
3 Sanjay Saraf Educational Institute Pvt. Ltd.
Advanced Capital Budgeting Decisions Class Work

= -10,00,000 + 3,27,272 + 4,46,281 + 4,05,710


= 1,79,263
3,10,293 - 1,79,263
NPV decrease (%) =  100  42.22%
3,10,293

d. Since PV of inflows remains at 13,10,293 the initial outlay must also be the same.
 Percentage rise = 3,10,293/10,00,000  100 = 31.03%.

Alternative Solution
If initial outlay increased by say 10%. The new NPV will be as follows:
20,000  20 30,000  20 30,000  20
NPV = -11,00,000 +  
1.11 1.12 1.13
= -11,00,000 + 3,63,636 + 4,95,868 + 4,50,789
= 2,10,293
3,10,293  2,10,293
NPV decrease (%) =  100  32.22%
3,10,293

e. Present value for 1st two years.


= - 10,00,000 + 4,00,000 x 0.909 + 6,00,000 x 0.826
= - 10,00,000 + 3,63,600 + 4,95,600
= - 10,00,000 + 8,59,200
= - 1,40,800
The project needs to run for some part of the third year so that the present value of return is
1,40,800. It can be computed as follows:
i. 30,000 units × 20 x 0.751 = 4,50,600
4,50,600
ii. Per day Production in ( ) assuming a year of 360 days =  1,252
360
1,40,800
iii. Days needed to recover 1,40,800 =  112
1,252
Thus, if the project runs for 2 years and 112 days then break even would be achieved representing a

fall of
 3  2.311  100  22.97%
3

4 Sanjay Saraf Educational Institute Pvt. Ltd.

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